Method and system for providing insurance protection against loss of retirement accumulations in a tax favored defined contribution plan in the event of a participant's disability

Abstract

A system and method for providing insurance protection against loss of contributions to tax favored defined contribution plans should an active employee / participant become disabled. The invention manages the administration of a disability insurance policy held inside the plan that continues contributions to the plan during a period of disability, where the coverage amount for each participant is determined by the level of contributions made by, or for, each participant.

Description

RELATED APPLICATION DATA [0001] This is a continuation of application Ser. No. 09 / 328,856, filed Jun. 9, 1999, now U.S. Pat. No. ______, which claims the benefit of provisional application Ser. No. 60 / 088,969, filed Jun. 10, 1998.BACKGROUND OF THE INVENTION [0002] 1. Field of the Invention [0003] The present invention relates generally to the field of employee benefits, and more specifically to systems and methods for insuring against loss of retirement benefits. Yet more particularly, the invention relates to, and is applied to, retirement plans established under United States Tax Law, and under Title 26 of the United States Internal Revenue Code. [0004] 2. Description of the Related Art [0005] Employee benefits are generally divided into welfare benefits (such as health care, disability and life insurance), qualified retirement benefits (may take the form of defined benefit pension plans or defined contribution plans), and non-qualified plans (such as executive wealth accumulation...

AI Technical Summary

Benefits of technology

[0034] The effectiveness of the invention in replacing lost contributions can be illustrated by examining the account values of four equally contributing plan participants at four different ages (35, 45, 55, 65). For each of the four individuals, final account value will be determined by one of these four situations:

[0035] a) He / she does not have the invention and does not become disabled;

[0036] b) He / she has the invention and does not become disabled;

[0037] c) He / she does not have the invention and becomes disabled;

[0039] For sake of simplicity, it will be assumed that disability for participants in situations c) and d) occurs at the beginning of the year in which they achieve age 40. It will also be assumed that all four participants are contributing $4500 per year to the plan and that all began contributing at the beginning of the year in which they achieve age 35. All participants make 24 payroll deposits to the plan each year and earn a 9% annual investment return. The premium for the insurance is $45 per year per participant and it is paid out of each participant's annual contributions beginning at age 36. Insurance benefits for the participant in situation d) are paid to the plan monthly after a 365 elimination period. Premium is waived at the point in which benefit payments begin. Never DisabledDisabled at Age 40AgeNot InsuredInsuredNot InsuredInsured35$4,699.51$4,699.51$4,699.51$4,699.5145$82,524.70$81,779.49$47,168.75$82,079.5950$266,756.24$264,255.84$111,665.58$265,572.3165$702,929.61$696,243.73$264,353.03$699,966.33

Problems solved by technology

Both form defects and operational defects may result in the IRS “disqualifying” the plan or imposing a “correction program” on the plan.

This plan typically does not address the needs of disabled employees after retirement age.

Therefore, an active employee is at risk that if he / she should become disabled and contributions to the plan are not made, the value of his / her plan account at the commencement of retirement will be substantially less than it would be if he / she had not become disabled.

The reduction in the value of the employee's account will produce a direct loss of retirement income to the employee.

If the plan allows benefits to be paid at disability, the available benefits are based on the accumulations in the account to date, and immediate payment of benefits from the account increase the likelihood that the account will be depleted before retirement age, further exaggerating the problem.

Even though retirement plans may include “incidental health and welfare” benefits, there was no known way to structure the insurance without complicating the “non-discrimination” requirements that apply to all “benefits, rights or features” for plans subject to IRS Section 410(b) testing.

Each outside the plan arrangement presents significant problems.

There are three main problems with this approach.

Problem One—The insurance may not be “linked” to employee deferrals.

And, since highly compensated employees and non-highly compensated employees elect deferrals at differing percentages of compensation, without the special tests applicable to deferrals, these contributions would not be able to pass the non-discrimination requirements.

Problem Two—The employee may be “over-insured.” Actuaries at most insurance companies are of the view that increasing the cash benefit payable during a disability will have an adverse impact on the rate at which some disabled individuals respond to rehabilitation.

This risk of over-insurance would require a substantial, disproportionately large increase in the risk charge that must be imposed as part of the premium for the group LTD policy.

Problem Three—The employee may not save the benefit for retirement.

If the employee spends the additional benefit before his / her retirement years, the employer's objective will not have been achieved and the employee still has a significant risk of loss at retirement.

There are three main problems with this approach.

However, the rule applies only if the participant is disabled under a very restrictive “any occupation” definition of disability.

Problem Two—Difficulty with Non-Discrimination Tests.

Since HCEs almost always make larger percentage of pay contributions than non-HCEs, if the employer continues the same level of contributions that it was making for the disabled individual prior to the disability and these tests no longer apply, the contributions would almost certainly be considered discriminatory.

And the disabled individual is at risk that the employer will go bankrupt.

There are three main problems with this approach.

These ERISA standards do not apply to the group LTD program and many employers do not provide LTD coverage to part-time employees.

If a sufficient proportion of non-HCEs who are participants in the 401(k) plan are not participants in the LTD program, the availability of disability coverage under the 401(k) plan may not pass non-discrimination tests.

Because of the application of the 401(k) and 401(m) non-discrimination tests with regard to average contributions for HCEs and non-HCEs, an HCE may not be able to replace his / her entire pre-disability contribution.

Such an increase in the deferral percentage for disabled HCEs would no doubt increase the average percentage for the HCE group and may result in failure of the 401(k) and / or (m) tests.

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